Analyst-Banker Firewall Weakened in Bill on Obama’s Desk

The new measure doesn’t directly address the 2003 global research analyst settlement, which stipulated that most of Wall Street’s largest firms could no longer have research arms that shared in the fees from stock offerings and other investment banking deals. Photo: Scott Eells/Bloomberg

April 4 (Bloomberg) -- After the dot-com bust a decade ago,
regulators forced Wall Street to adopt rules aimed at keeping
stock analysts from over-praising companies doing deals with
their banks. President Barack Obama is set to sign a law that
would undo at least some of the changes.

One measure in the bill, passed by Congress March 22 to
ease securities rules for closely held firms, would restore
communication between bank research and underwriting arms. Those
links were restricted in 2003 by regulators and by a separate
settlement between then-New York Attorney General Eliot Spitzer
and 10 firms including Goldman Sachs Group Inc. and JPMorgan
Chase & Co.

Spitzer forced the banks to restructure their practices
after his office obtained internal e-mails from Merrill Lynch &
Co. analysts who privately called dot-com stocks they had
recommended “dogs” and “crap.”

“It undoes part of the regime set in place through the
analyst settlement,” said Stephen Crimmins, a former Securities
and Exchange Commission enforcement lawyer who is now a partner
at K&L Gates LLP in Washington. “It’s possible we’ll see some
of those parties involved in the settlement ask the court to be
relieved of their undertakings.”

Obama is scheduled to sign the bipartisan agreement
tomorrow. When it becomes law, regulators will no longer be able
to write or maintain rules that restrict investment bankers from
arranging communications between analysts and investors when
dealing with firms with less than $1 billion in gross annual
revenue.

Ending Blackouts

Analysts also will be able to join investment bankers on
meetings with the management of qualified firms, as well as have
the freedom to publish research reports on firms immediately
after an initial public offering instead of waiting for a
blackout period to end.

“It appears that it will eliminate some provisions of the
analyst rules with respect to emerging growth companies,” said
Nancy Condon, a spokeswoman for the Financial Industry
Regulatory Authority, which oversees more than 4,000 brokerage
firms.

Spokesmen David Wells of Goldman Sachs, Joe Evangelisti of
JPMorgan and John Yiannacopoulos of Bank of America Corp., which
purchased Merrill Lynch in 2008, declined to comment on what if
any changes firms may make under the new law.

2003 Settlement

The new measure doesn’t directly address the 2003 global
research analyst settlement, which stipulated that most of Wall
Street’s largest firms could no longer have research arms that
shared in the fees from stock offerings and other investment
banking deals and instead had to rely on a shrinking pool of
revenue generated from equities trading. It also mandated a
separation between the two sides.

“One of the things that I think the investment banks that
are party to the global settlement are likely doing now is
taking a hard look at the global settlement provisions, to see
how they may affect how those banks might modify their policies
and practices going forward,” Glenn R. Pollner, a partner at
Gibson, Dunn & Crutcher in New York, said in an interview.

The SEC is also reviewing the bill’s impact on the
settlement, according to a person briefed on the discussions who
spoke on condition of anonymity because the matter isn’t public.

For those opposed to the new law, including Democratic
Senators Carl Levin of Michigan and Jack Reed of Rhode Island,
the provisions mark a rollback of protections that will open the
door to new conflicts of interest between investment bankers and
analysts.

Venture Lobbying

The National Venture Capital Association, a trade group
that lobbied heavily for the new bill, said the current
restrictions have held back the growth of new companies because
they haven’t been able to get analysts’ attention.

Regulations have “limited the amount of research about
these emerging companies available to investors, constraining
investor interest,” Mark G. Heesen, president of the venture
capital group, wrote in a February letter to lawmakers that was
co-signed by Duncan Niederauer, the chief executive officer at
NYSE Euronext.

Supporters of the law said that protections for investors
remain in place. For instance, the bill doesn’t upend a rule the
SEC finalized in 2003 that requires researchers to certify that
their reports reflect their personal views and disclose whether
they were compensated for those views.

‘Robust’ Rules

“To date, the discussion of these issues has often
overlooked the detailed, substantial and robust regulations that
continue to apply to research,” Joel Trotter, a partner at
Latham & Watkins LLP and a member of the IPO Task Force, a group
of lawyers, academics, bankers and venture capitalists that
presented a report to the Treasury Department last year on how
to boost the IPO market.

Heesen and Niederauer, in their letter, said the changes in
the law would correct a problem faced by many firms looking to
go public -- they can’t get enough interest from investors
because research analysts don’t have an incentive to cover
smaller or marginal companies. The current rules force analysts
to focus on “high-volume, high-liquidity large-cap stocks that
now drive revenues for their institutions and provide the basis
for their compensation,” the IPO task force wrote in its
October report.

“You can expect some form of research on IPO issuers to
become a regular part of the deal landscape for companies that
are going public,” Trotter said.

SEC Opposition

Among those who didn’t welcome that prospect was SEC
Chairman Mary Schapiro, who told lawmakers in a March 13 letter
that the measure would “weaken important protections” that
separate analysts from investment bankers in the same firm, as
well as rules that bar firms from promising potential clients
favorable research in return for underwriting assignments.

Levin, one of the co-sponsors of an amendment that would
have stripped the changes, cited the dot-com bubble in his floor
remarks against the underlying bill, which was eventually passed
in the Senate 73-26 and cleared by the House 380-41.

“This abuse helped feed a stock bubble that, when it
burst, wiped out investors, evaporated companies and devastated
the economy,” Levin said on March 22. “It is astonishing that
we would forget these lessons and allow the return of such
blatant conflicts of interest.”